Oct 22, 2013

OCC Due Diligence Guidelines: Maintaining Effective Portfolio Risk Management

To verify that institutions meet soundness requirements that are appropriate for their individual risk profile, based on the size and complexity of their portfolios, in accordance with the new regulations set forth in the Dodd-Frank Act, the Office of the Comptroller of the Currency (OCC) has set forth additional guidance to assist banks in meeting due diligence requirements in assessing credit risk for portfolio investments.

In this video blog Slavek Rotkiewicz, President & CTO of TPG Software joins Jim Jockle, CMO of Numerix to discuss the impact of regulatory changes on derivative accounting, valuations and managing risk. Slavek and Jim go through some of the key guidelines and discuss how an institution can best meet new compliance mandates.

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.

Video Transcript: OCC Due Diligence Guidelines --  Maintaining Effective Portfolio Risk Management

Jim Jockle (Host): Hi welcome to Numerix Video Blog I’m your host Jim Jockle. Today joining us is Slavek Rotkiewicz, President and CTO of TPG Software. Slavek how are you?

Slavek Rotkiewicz (Guest): I’m good, how are you guys?

Jockle: Very good and thank you so much for joining us today. Recently earlier in September, the Office of the Comptroller of the Currency set fourth additional guidelines to assist banks needing due diligence requirements for assessing credit risk within portfolio investments.

One of the questions I really just want to start with you Slavek is how are institutions adapting and changing to meet these compliance mandates? Especially around the accounting side but also in terms of the risk management of derivatives within their portfolio under these guidelines.

Rotkiewicz: Well it seems like part of it is documenting. It all revolves around pre-purchase analysis. And there’s a move away from relying on rating agencies but relying more on the banks own expertise and going through the checklist that’s provided by OCC. And it started with larger institutions but I think as the timeline goes, it goes down to 10 billion in assets and below now.

Jockle: And you talk about lack of reliance on rating agencies. As it relates to ratings embedded in terms of investment guidelines, is that use of standard ratings in terms of assessment of probability of default in thinking that credit risk analysis in-house. How would you define lack of reliance?

Rotkiewicz: Part of the OCC put together in their checklist is that there are specific steps that are tied to particular asset classes. So for example for municipal bonds or corporates, there is a lot more emphasis on credit worthiness, a very particular institution, issuer or municipality as far as their financials. How sound are their financials? How sound is their income and revenue, or tax basis.

When you move to structured products MBS, CMOs it goes down to what is the structure of the product, that’s the impact of prepayment on a particular tranche. There’s some credit worthiness emphasis but it’s much less. You know a big proportion of those are agency bonds so there’s not as much issue with that.

Jockle: And with this type of analysis, how are systems evolving to handle that kind of capability. You know if I’m thinking structured products, I’m thinking drilling down into pre-payment models then looking at fundamental credit analysis.

I’m thinking just more wider tools to have a better prospective of probability of default or even looking at market base indicators like CDS, where available. How is technology helping the evolution for these firms that perhaps did over rely on ratings?

Rotkiewicz: I think there are better mathematical toolkits out there in the market place. Also there’s a variety of data vendors that specialize in particular data subsets. There’s also a trace where you can compare comparable transactions. And part of it is documenting, and part of it is actual analytics, so traditional analytical systems I think like Bloomberg, or Yield Book, or BondEdge, might take a big part of it, but there is lots of issuer information that simply not available. And I think that’s the direction is for particular institutions to really rely on their own expertise on evaluating those particular issuers or counterparties if you will.

Jockle: Arguably one can say clearly the days of straight line accounting for portfolios are gone with requirements around pre-trade analytics and in the accounting forums including monthly cash flows and amortization methods. Can you elaborate on how institutions can become a little bit more in synch with the economic side of the trade?

Rotkiewicz: So what we see is that the same cash flows that are used to evaluate a potential security or performance are used now to drive accounting. And so you have a convergence of economic value of the bond with actual accounting. How it’s going to be done and for all mortgage backed passed from CMO’s, asset backs.

For those instruments, of course cash-flows change every month so it requires evaluation and there’s a bit of a move into stressing cash flows due to potentially interest rates rising or what not or pre payments changing due to the regulation or just the marketplace. And we are happy for that obviously and I think it’s going to be better for all institutions and it would be easier to audit as well but that’s the move that we change and we make provisions to comply with that.

Jockle: Well hopefully now with some of the government issues behind us or at least pushed back to February of 2014 we can see the reemergence of the bull market on the equity side of the house and fixed income will continue a little bit of a rally now that we have quantitative easing and the markets will stay robust and earnings will continue to look very good.

Slavek I want to thank you so much for your insights today. And to learn more about TPG Software, please feel free to visit their website as well as you can connect to Slavek and myself on LinkedIn.

And please feel free to stay in touch with all elements of Numerix, on Numerix’ LinkedIn site as well as on twitter @nxanalytics and of course we want to hear the topics you want us to cover. Slavek thank you so much for joining us today. And I hope you’ll join us again soon.

Rotkiewicz: Thank you Jim.

Jockle: Thank you.

Rotkiewicz: Bye.

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